More Employees Will Be 162(m) Covered Employees under the American Rescue Plan Act

The American Rescue Plan Act (ARPA), passed by Congress and signed into law on March 11, 2021, expands the definition of “covered employee” under Internal Revenue Code Section 162(m), requiring the inclusion of an additional top five highest paid employees (beyond those officers already counted).

Section 162(m) imposes a $1 million deduction limit on remuneration paid to a covered employee. Currently, covered employees for a particular tax year include the principal executive officer, the principal financial officer, and the next three most highly compensated officers (the Five Officers). The 2017 Tax Cuts and Jobs Act (TCJA) changed the Section 162(m) rules for tax years after December 31, 2016, so that an individual’s status as a covered employee will continue even if he or she is no longer among the five highest paid officers (e.g., for purposes of compensation paid after he or she terminates from employment with the public company). Therefore, today the list of covered employees includes the Five Officers and anyone who was one of the Five Officers for tax years beginning after December 31, 2016.

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409A/162(m) Payment Delay Provisions

Public companies that sponsor nonqualified deferred compensation plans that require Internal Revenue Code Section 162(m) payment delays may want to consider whether removing the payment delay provision from a plan is warranted in light of the 2017 Tax Cuts and Jobs Act (TCJA) changes to the definition of a “covered employee.” The December 31, 2020 deadline is approaching to amend plans to remove Section 162(m) payment delays without the change being considered an impermissible acceleration of payment under Internal Revenue Code Section 409A.

Section 162(m) imposes a $1 million deduction limit on remuneration paid to a “covered employee.” The TCJA changed the Section 162(m) rules so that an individual’s status as a “covered employee” will continue after he or she terminates from employment with a public company. Prior to the TCJA change, an individual ceased to be a covered employee for purposes of Section 162(m) when he or she terminated employment. This change to the “covered employee” definition applies to tax years beginning after December 31, 2016. As a result, covered employees identified for a public company’s 2017 tax year (in accordance with the pre-TCJA rules for identifying covered employees) continue to be covered employees for the company’s 2018 tax year and thereafter.

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